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Leon Cooperman and Steve Einhorn first teamed up in 1977, when Cooperman, then head of equity research at Goldman Sachs, hired Einhorn as a U.S. equity portfolio strategist. Cooperman left to start Omega Advisors in 1991. And on retiring from Goldman eight years later, Einhorn teamed up with him again. Today, Omega manages $8.5 billion, much of it in stocks, and given their bullishness right now, almost all of it long.

While Cooperman, 70, and Einhorn, 64, don't finish each other's sentences, they think enough alike to finish each other's paragraphs. Says Einhorn: "Lee has an ability to isolate the critical variables that will ultimately determine the direction of a stock price before many others do."

Cooperman returns the compliment, lauding Einhorn's smarts and judgment, and calling him "a man of integrity who cares about the clients of the firm and me. What more can one ask of a partner?"

That combination has paid off for investors. Omega's main fund, Omega Overseas Partners, is up 15.6% a year on average over the past three years, compared with 10.9% for the Standard & Poor's 500.

Cooperman: Throughout the post-World War II era, the average stock-market decline in a bear market is about 25% and lasts about 10 months. So the bear market that ended in March of '09 was twice as severe as the average. Most bear markets are induced by economic contractions. During the average recession in the postwar period, real gross domestic product goes down 2% from peak to trough. The most recent recession was about twice as severe in magnitude, so you had a bear market twice as severe as the average bear market, and the market discounted twice as severe an economic contraction.

The average economic expansion lasts about five years. If we had to make a guess, it would be that this expansion will be longer than average. One reason is a large GDP gap—that is, the difference between actual output and potential output. There is a large employment gap, and an important sector to the economy is housing, which is still operating well below normalized demand.

What kind of economic growth do you expect?

Cooperman: It's moving in the right direction. Our model forecasts about 2.5% real GDP growth for 2013. So the economy is fine, and the Federal Reserve, in my humble opinion, has created an environment where there is no effective alternative to common stocks.

What lessons did you take away from that downturn?

Cooperman: We totally misunderstood the significance of the Lehman insolvency and its impact on the economy, and we weren't alone. The U.S. government didn't understand it; most people didn't understand it.

Einhorn: The surprise with respect to Lehman was the reach it had into so many other financial institutions and the freezing of credit that it brought about. The recession we experienced in 2008 and the first half of 2009 would not have been nearly as severe without the freezing of credit flows between financial intermediaries as a result of the Lehman insolvency.

"There is no effective alternative to common stocks," says Cooperman, right. Einhorn says the same.
Photograph by Gary Spector

Let's hear about your outlook.

Einhorn: We look at it through two time frames. The near-term outlook is less relevant to us as investors, but it's important to note. The second time frame, the longer term, is more important to us as investors. In the near term, the S&P 500, as representative of U.S. stocks, is somewhat disconnected from economic activity and earnings fundamentals, and the market seems stretched because of that.

So, for a whole host of reasons, I would expect the market to enter a prolonged consolidation, at around current levels. The basis for that consolidation is, first, the market is up 12% in the first four months of this year. That's 3% a month. The average monthly gain for the S&P is about seven-tenths of 1%. So, just on the surface, the year-to-date advance has been rather extreme.

Second, if you look at the sectors that have led the market for most of this year, they are defensive: health care, utilities, telecom, and consumer staples. Rarely, if ever, does the U.S. equity market march to new highs on the back of defensive, noncyclical industries. Third, earnings are challenged. Excluding financials, for the S&P 500 in the first quarter, year-over-year earnings growth was about 1% to 2%. Revenue growth was essentially flat. So there is not much earnings growth, and what earnings growth there is isn't sourced in revenue. It is sourced in cost-cutting, with margins at a record that can only go so far.

Cooperman: He is not saying the bull market is over; he's saying it's ahead of schedule.

And after the bull takes a breather?

Einhorn: We should resume an upward trend. I agree with Lee that the current economic expansion, which started in June 2009, will last well beyond the 60-month postwar average. In fact, we expect it to be long-lasting. As Lee mentioned, there is the output gap, meaning there is a lot of excess capacity. The unemployment rate is well above average. But in a more granular sense, every cyclical sector of the U.S. economy now is showing pent-up demand that is below trend.

Another reason for a long expansion is the recovery in home prices. Home prices are critically important to consumer net worth, confidence, and spending, and home prices are accelerating. And consumer net worth today is almost back to where it was at the peak in 2007. That will underpin a steady advance in consumer spending in the U.S. economy. Also, none of the metrics that typically signal the arrival of recession are with us today, nor do we expect them anytime soon.

Are you worried that the Fed will have a hard time unwinding its balance sheet?

Einhorn: First of all, it is not an issue that investors will have to contend with for at least the next 12 to 18 months, which captures a good deal of most investors' time horizons. Second, the Fed does not have to actually sell assets off its balance sheet. All it has to do to unwind its balance sheet is to let those securities mature. And as they mature over time, the Fed's balance sheet declines. This notion of an abrupt end to QE is wrong. What they will do is taper it off. They have been buying $85 billion a month of securities. So, for example, when they begin to taper that off, whenever it happens, they'll go to $75 billion a month, then $65 billion, or whatever the number happens to be. Tapering off should not be a jolt to economic activity or the markets. All they have got to do is let these assets mature and roll off.

What impact have Ben Bernanke and the Fed had on the stock market?

Cooperman: For the first two or three years, investors didn't believe him because they were basically reacting to the scares of the 2008 debacle. Now he's succeeded in getting the market to its own fair valuation. At Omega we ask ourselves every day, "What's unusual about the environment? What's normal, and where should the market be if everything was normal?" We have slight differences of view. But to me, what is unusual is the more than $600 billion deficit and zero interest rates. They really kill the savers in this country.

Einhorn: The Fed's policy has protected the equity market from bad economic and earnings news. Bad economic news encourages investors to think that QE will last longer; good economic news is good because it underpins better earnings growth but also because near-term economic strength is not deemed sufficient to deter the Fed. So, bad news is good news for stocks, and good news is good news for stocks. This, along with the lack of return in fixed income, is a reason to think the bull market can persist after a period of consolidation. So the market's downside risk is limited.

Cooperman's Picks

Name/Ticker

Recent Price

Citigroup / C

$51.34

Sprint Nextel / S

7.25

Transocean / RIG

55.11

Source: Bloomberg

What does normal look like to you?

Cooperman: Normal would probably be $100 in S&P operating earnings this year. The market multiple is 15 or 16 times; the average long-term multiple is around 15. So there is a zone of fair valuation from 1,500 to 1,600.

Einhorn: When the inflation rate has been between 1% and 3%—where we are now—the average forward price/earnings multiple is nearly 17 times; so based on that, it's cheap. Put simply, stocks are cheap relative to interest rates and inflation.

Cooperman: Keep in mind that the average yield on the 10-year Treasury going back to the 1960s is 6.67%, versus 1.7% now. So stocks are very, very cheap against the alternatives in financial assets.

What are you seeing as far as investors looking for more yield?

Cooperman: Everyone is in the process of moving up the risk curve. We have an investor who put all of his money in T-bills when he retired, because he didn't want duration risk or credit risk. So for the guy who bought T-bills, he can't get any return anymore, so he migrated to T-bonds. The guy who bought T-bonds has migrated into industrial credits. The buyers of industrial credits have migrated into high yield. The high-yield buyers have migrated into structured credit, where we are now in our credit exposure at Omega, and the structured-credit people are increasingly looking at equities. So everybody is moving up the risk curve.

That helps equities, no doubt?

Einhorn: There is no effective alternative to common stocks and people are getting fatigued sitting on cash earning zero and bonds, which have such unattractive returns.

Let's talk about some stocks in your portfolio.

Cooperman: What I like about Transocean is that they are dominant in ultra-deepwater drilling. They have earnings capacity in excess of $7 a share. Last year, they earned nearly $4 a share. The stock is trading at $55. We happen to like management. Carl Icahn doesn't like management as much, but generally speaking, he is in there to mix it up, and we'll let him do the mixing up. But the stock is cheap relative to its underlying asset value. The value of their fleet is around $70. The stock is trading at more than seven times its earning capacity, and that $7 doesn't necessarily represent a peak. It pays a nice dividend, so you are being paid 4% while you wait. That compares to a 2% yield for the market. The market is trading at over two times book, and we believe the real book value of Transocean is $70, so it is trading at a discount to book.

Another, please?

Cooperman: Our largest position is Sprint Nextel. The underlying business is improving. We have a very high regard for Masayoshi Son, the CEO of
SoftBank9984.TO 0.4235112936344969%SoftBank Group Corp.Japan: TokyoJPY7825
330.4235112936344969%
/Date(1481317200000-0600)/
Volume (Delayed 20m)
:
17335800
P/E Ratio
10.924651318636826Market Cap
8130578190125
Dividend Yield
0.5623003194888179% Rev. per Employee
141554000More quote details and news »9984.TOinYour ValueYour ChangeShort position
[9984.Japan], which is bidding for Sprint Nextel. We've also owned
Dish Networkdish 2.199863574351978%DISH Network Corp. Cl AU.S.: NasdaqUSD59.93
1.292.199863574351978%
/Date(1481234400252-0600)/
Volume (Delayed 15m)
:
2519732AFTER HOURSUSD59.93
%
Volume (Delayed 15m)
:
19879
P/E Ratio
28.67464114832536Market Cap
27269664671.1952
Dividend Yield
N/ARev. per Employee
841615More quote details and news »dishinYour ValueYour ChangeShort position
[DISH] for a long time, and it's also bidding to acquire Sprint. So we're sitting in a very good position. We have two titans of industry who want to own the same asset, Sprint. Before this is over, the stock, which traded recently at $7 and change, will have an eight in front of it, and that will happen sooner rather than later.

How about a financial stock?

Cooperman: One of our holdings is Citigroup, which trades at around $50, or roughly 0.9 times tangible book value. We believe the new management at Citi can more than double its return on tangible equity in the next two to three years by reducing the drag from the runoff of the Citi Holdings entity, which consists of businesses and portfolios that the company is exiting.

The installation of Michael Corbat as CEO, along with Michael O'Neill as chairman, was an important inflection point. O'Neill has proved that he can turn around franchises, most recently at
Bank of HawaiiBOH 2.1629084215370455%Bank of Hawaii Corp.U.S.: NYSEUSD88.8
1.882.1629084215370455%
/Date(1481234521057-0600)/
Volume (Delayed 15m)
:
217528AFTER HOURSUSD88.8
%
Volume (Delayed 15m)
:
2083
P/E Ratio
21.142857142857142Market Cap
3710875550.79407
Dividend Yield
2.1621621621621623% Rev. per Employee
289860More quote details and news »BOHinYour ValueYour ChangeShort position
[BOH] after the dot-com bubble burst. Citi can earn at least $5 a share this year, versus a consensus of $4.70, primarily through cost-cutting and reducing losses at Citi Holdings. By the end of 2014, through a combination of cost-cutting, buybacks, noncore-asset sales, and winding down runoff entities, Citi can be a $70 stock.